Analysts: August Interest Rate Might Be Cut

A cheaper shekel makes Israeli imports more attractive, and lower interest rates in Israel reduce foreign demand for shekel-denominated investments.

Industry analysts think the Bank of Israel's monetary committee might decide today to cut the August interest rate by 0.25% to 2%. Last month, the panel lowered the rate from 2.5% to 2.25%. An official announcement of a decision by the monetary committee will be released today at 5:30 P.M., after the close of trade on the Tel Aviv Stock Exchange.

Opinion has been divided among analysts over the timing of another drop in the interest rate. Some experts think the decision to reduce it to 2% will be announced today; others believe that the ongoing drop in the value of the shekel against the U.S. dollar in recent months reduces the need for a cut in the interest rate. A cheaper shekel makes Israeli imports more attractive, and lower interest rates in Israel reduce foreign demand for shekel-denominated investments - and in the process also tend to depress the value of the shekel.

Some observers think a drop in interest rates will come next month, or at the very least by the end of the year.

The arguments for a drop in the August interest rate is supported by June's consumer price index, which surprisingly registered a drop of 0.3%. This diminishes any possible concern that loosening availability of funds would spike inflation. The belief in the need to cut the interest rate is also supported by the recent slower economic growth and slackening local demand, as well as by fears of higher unemployment and weak foreign trade figures.

Inflation for the past 12 months ran at 1%, which is the lower end of the government's 1% to 3% inflation target range. Data from March through June reflect an annual inflation rate of just 0.6%, actually under the target range. Capital market data show inflationary expectations of 2% in the coming year, which is roughly in line with the 1.9% range projected by the banks and financial firms.

Support for leaving the August interest rate at 2.25% is buttressed by concern over a real estate bubble if the rate is reduced, following a drop in mortgage rates and the continued demand for housing. [Also see page 11 story on mortgage rates]. Also cited as a factor favoring an unchanged rate is the uncertainty over the 2013 state budget and a lack of clarity over possible tax increases.

In Leumi Capital's weekly macroeconomic survey, David Reznik cites the devaluation in the shekel against the weighted basket of currencies of Israel's major trading partners; the unresolved issue of the extent of Israel's budget deficit; and the prospect of elections taking place before the fall of 2013, which is the latest they can occur, as reasons the central bank may leave the August rate at 2.25%. Reznik predicts the interest rate will be reduced to 2% by the end of the year, but not now.

That prediction could change, he cautioned, if there are major developments in the world economic crisis or with the Israeli budget deficit, but nothing of this sort can be expected in the near future. Reznik said he did not think the 2013 budget would be approved by the end of this year and added that the U.S. Federal Reserve is not currently interested in expansionary monetary steps.